How Stable Is the German Pension System? – "A Tax-Financed Model Could Make the Pension System Sustainable"

Almost half of all Germans retiring after 2030 will receive pension benefits placing them below the poverty line. This is a dour prospect, particularly when considering increasing life expectancy. Calls for the reform of the pension system have thus been growing louder. ZEW economist Andreas Peichl argues that the options for placing the German pension system on sound footing are limited. For Peichl, there is a need to ensure greater balance between young and old, as well as a more socially just distribution of burdens.

There have been increasing calls for establishing 70 as the new statutory retirement age. With life expectancy rising, the number of years worked by employees paying into the system must be increased to ensure adequate benefit levels. What is your opinion of this proposal?

Establishing 70 as the retirement age is both reasonable and necessary. Our pension system was created at the end of the 19th century, and the retirement age was originally 70, despite an average life expectancy of just over 50. Today, we have a fundamentally different situation. For a long time, strong productivity growth made it possible to cover the cost increases of rising life expectancy. Increasing life expectancy doesn't just increase the number of pensioners, it also increases the number of years benefits are paid out. At the same time, there are fewer young people to shore up the system. For this reason, the current system, which uses contributions collected now to pay current liabilities, is effectively no longer viable. The increasing number of pensioners in relation to the number of working-age people means that the system is no longer sustainable over the long term. Reform is imperative.

The pension system is perhaps better than its reputation. Yet there are many options for reforming the system, aside from focusing on the retirement age. How should the current pension system model be changed by policy-makers?

Essentially, policy-makers have three options: they can increase contribution rates, decrease pension benefit levels, or decrease the benefit period by increasing the retirement age. Increasing contribution rates is not a good option, as this would increase the burden on labour, thus leading to more unemployment. As we have a pay-as-you-go system, one could consider lowering pension benefits for individuals without children, as the system is based on current payments made by the younger generation, not the contributions one previously made. However, this would be politically difficult to implement. Thus, changing the statutory retirement age appears to be the only viable option. However, establishing 70 as the retirement age does not mean that everyone will have to work to this age. One could retire earlier, but would have to accept a lower monthly pension.

Many people are afraid of collecting a pension that won't cover their needs. How serious is the risk of old-age poverty?

It is true that statutory pension benefit levels are only designed to cover a portion of the income required after retirement. Private retirement savings are thus important. Of course, if the pension benefits one is collecting are insufficient, one can draw on other government benefits, such as the housing allowance or welfare. Nevertheless, we should give thought on principle to the replacement of our pay-as-you-go system with a tax-financed model that provides a basic pension above the poverty line, as is the case in Sweden, for example.

Does Germany's three-pillar pension model have a future?

Of course. However, a few reforms are necessary to make the system sustainable for the future. We should keep the current combination of government-based pension benefits and funded private pension insurance. One could also discuss whether reform is necessary to the "Riester pension". However, the more important step is to reform the pay-as-you-go system currently used for government pensions. I think the pension contribution system should be changed so that the system is financed from taxes based on a different set of tax rates, as is the case in Denmark. As a result, proceeds would no longer be collected solely from employee wages. This would also ensure that all individuals are paying into the system – including civil servants (who have their own pension system in Germany) and the self-employed (who do not currently pay into the system). Furthermore, this would eliminate the cap on contributions, ensuring the fairer distribution of burdens. In the current system, a disproportionally high burden falls on the middle class. These reforms would put the pension system on sound footing for the future.